How Companies Fail

As Warren Buffet has so famously said, “When the tide goes out, you see who’s not wearing a bathing suit.” Well, the tide has certainly gone out and there are a lot of naked companies around. Many of the failed companies will insist that they had been the victims of a “perfect storm.”

However, in the years to come, it will become apparent that some companies have actually used the crises to gain market share, increase employee loyalty and enhance profitability while their competitors were crumbling.

Why do some firms prosper when others fail?

The crisis has already produced a lot of post-mortems and no small amount of schadenfreude. Jim Collins has rushed out a book on companies that fail (probably his best), and there are already numerous articles and discussions on cable TV of varying quality.

Some of the commentary is thoughtful, some sanctimonious, and some theatrical. Yet, muddling through the pundits and insiders, as well as my own personal experiences, one theme becomes clear:

Failures share common attributes and are therefore shouldn’t be that hard to spot long before the situation becomes irreversible. The companies that fail are the ones who don’t believe the rules apply to them.

What a Failing Company Looks Like

Overconfidence: Collins covers this aspect at length, and he makes the very good point that organizations get overconfident due to past success. Moreover, they often forget or confuse the reasons they were successful in the first place.

For instance, they discount luck that they had (which always plays a role), and build narratives starring themselves as the heroes. They believe that they succeeded due to some inner magic that they alone possess.

Where others see ambiguity, they see certainty. After all, they have triumphed because they always knew better. Why should they listen to the doubters now?

Overvaluing Strategy and Undervaluing Process: Companies that endure build superior processes over the long term. Thousands of small incremental improvements build up over time into an enormous competitive advantage.

One never hears of brilliant strategies from the likes of GE, Microsoft or Goldman Sachs. These boring companies merely plod along, dominating their industries year after year, for decades.

Companies headed for trouble focus too much on grand strategy and too little on how things get done; too much on numbers and not enough on math. A “strategically driven” company is usually too focused on senior management and not enough on the people implement process.

There is also usually a heightened sense of urgency and a fairy tale quality – Cinderella is in such a rush to get to the ball that she can’t bother to notice that her carriage is rusting and the wheels are about to come off.

Looking for Dragons to Slay: A company at the height of its success often feels all-powerful and looks for exciting new challenges. Frequently, they seek out new, more inspiring lines of business out of boredom and hubris rather than specific business objectives.

Company leaders usually talk about “taking the company to the next level” during this stage, having outgrown their present lines of business; they feel it’s time to take new risks. Another characteristic is that they often want to “re-engineer” the company. A company that needs to be re-engineered is in big trouble.

At- risk CEO’s often become media darlings and start using words like “vision” and “transcend” They are all too eager to explain to the uninitiated the heights they plan to conquer. To the doubtful, they simply point out that “you can’t argue with success.” Yet, that isn’t much of an answer. Great failures are born out of great successes.

Disruptive Competition: An enterprise that is full of itself and looking to conquer new worlds can fail to notice that trouble is lurking beneath the surface of their core business. A disruptive threat is never obvious so it’s easy to miss.

Sometimes a new product focuses on the most unprofitable consumers and makes the incumbent’s business actually perform better financially. Other times, the disruptive product targets non-consumption and actually increases the overall category penetration before it starts taking customers from incumbents.

Whatever the case, disruptive competition is a dire threat because it isn’t obvious. Frequently, it is only amount of time before the technology improves, the basis of competition shifts and a powerful incumbent finds itself in deep trouble. (See What Is Disruptive Innovation?).

The Lambda Response: Once trouble starts, how a company responds will have a lot to do with whether it ultimately survives. A cautionary example can be taken from biology and the well known Lambda virus.

This type of virus can lie dormant on host DNA for years. It is nearly undetectable and reproduces along with the cell. To all appearances, it is harmless. However, when the cell comes under stress, chemicals are released to protect the organism. Unfortunately, these same compounds alert the Lambda virus that the cell is at risk, which then enters its “lytic” phase. It multiplies itself millions of times, eventually bursting and killing the cell.

In other words, sometimes the cure is worse than the disease.

Many companies in distress fall victim to the same response. Their reaction to the crises alarms employees, partners and clients alike. Latent frustrations and suspicions come quickly to the surface, exacerbating an already dire situation.

Panic replaces hubris as the company zeitgeist; decision making becomes choppy and irrational. Pointing fingers alternates with speeches to rally the troops and a series of new strategies, but trust has been lost. To paraphrase Gary Hamel, there is no longer a community of purpose.

The Sisyphus Solution

Management theorists offer many solutions, both to maintain corporate greatness and for companies in distress. Here, I’ll propose just one.

In the Greek myth, Sisyphus was condemned to roll a boulder up a hill, only to have it fall back again so that he could repeat his task. The French writer Albert Camus imagined Sisyphus at the bottom of the hill, about to renew his labor, as at his happiest; reveling at the task at hand.

When company leaders are like Camus’ Sisyphus, they are most likely to be successful. Companies who are focused at the task at hand, rather than building empires and seeking out the “Next Big Thing” are doing their shareholders the greatest service. For a company to be profitable over the long term it has to perform and that can only happen if the organization is united in its purpose.

Once management loses the passion for developing superior products, serving their customers and creating a great workplace, trouble lies ahead. Whatever appearances might lead observers to believe, the company is on the road to failure.

In the final analysis, some people are serious about creating value and some people have other ambitions. That’s the difference between a businessperson and a “big-shot.”

1-The goals are not set
2-No follow-up on what each employee is doing
3-No KPI monitoring
4-Employ more ‘white elephants’ (who doest understand business) as managers
5-Pay more salary than what they deserve

I appreciate the perspective and agree with all of it. I would like to see (and may be the one that does it one day) other sources that would truly break down why start-ups fail. When I have spoken to VC/PE firms, with all of their educational and executive pedigrees, they are still only expecting success 1/3 of the time (my most recent meeting). Because they still deliver back a 30% return with this kind of track record, they feel successful. Instead, I look at what they didn’t get right in the ones that failed. Who other than an MLB baseball player accepts batting .333 and calls it success. I believe that people get such a sense of success that they don’t really care enough about what else they are leaving on the table; not out of greed, but rather out of prudence and effectiveness.

I’ll mention a few thoughts. One is the fact that their initial decision making is flawed. Yes, they have seen thousands of business plans and feel they are good at weeding thing out. However, go back to the 33% success ratio……I don’t think they are as good as they think. Though this is going to come out as sour grapes or skewed, I have a service company that I am working to get funded. “On plan” (with ever attempt to be conservative) we are cash postive by the end of year 1 with a ($600k) loss. Year 2, $24M in revenue with a $13M pre-tax income. This is with a total $3M one time capitalization. Now, understand, you along with anyone else may think I’m smoking that rose-glasses entrepreneur’s crack. However, I am 1. a startup that requires more than $1M in capital….thus an anaphalactic allergic reaction. 2. I have a capital intensive “big-bang” creation vs. the slow, crawl-walk-run traditional creation. 3. I have a very lack lustre, non-sexy industry segment that we are changing. My key point to this is that I have had no one that has stopped and said “hey, let me see how you really get these numbers and if this is reality based or not.” The industry leader in this space operates on a 60%+ gross margin with a poor national reputation. Back on point, decisions are made too quickly….I think a lot on the fad du jour bandwagon effect for one. If I had a software company that had some intellectual property, say for a new/better/different physician practice management software, I guarantee I would have been well funded a year ago. Very nice surface industry #’s. However, the sales cycle is long, and expensive. There are well established large players. This is a space with billing modules that are nuts and have to be build based on individual payor contracts in many cases. Many many of these companies get funded, but don’t understand that even with a better mousetrap, its not marginally better enough to warrant enough buying behavioral change to make the company work. Sexy space, bad dynamics….let alone that its over-crowded because people will fund it.

Another point that I touched on is that the spotlight/sexy segments are a bandwagon modle that is one of those things like running with the herd off a cliff together. Its amazing the opportunities that lay off the beated path. The service segment we address is such a case. Its a very interesting case study on the lack of evolution of a whole industry, but survives based on some unique dynamics. VC/PE groups, because of the deal flow in their very narrow scope actually have as much blinders on as they do focus sometimes.

Here is my opportunity to offend theory: If you look at the background of the majority, or at least a disporportionate number of VC people, they are finance people. What is the personality typology and norms of this group. By nature, they are not the creative/entrepreneurial/visionaries. They are the ones that make sure the “i”‘s are dotted and the “t”s crossed. They are organized, structured, and evaluate in a digital dynamic of pass/fail. This mindset and background, if not mixed with industry sales and operational experience won’t understand selling cycles and multiple other softer behavioral dynamics, human resource supply/demand dynamics, corporate culture, etc. that end up having every bit if not more to do with a company’s success vs. whether they fit the textbook definition of a successful organization.

Enough is already said about management/leadership teams. However, I will point out that not a good depth of understanding and evaluation of them is done. Just because someone has “been there/done that” doesn’t really give clarity to the multitude of cause/effect dynamics to that historical success. There are too many to take time to list now, but having spent 18+ years in the retained executive search industry, I can assure you that there is not enough qualitative and critical interviewing of managment/leadership teams that goes into this. I have had both angel investors and an angel fund that is considering investing in my company. Not a soul has asked to meet or speak with the other two senior executives that I have recruited (who are excellent btw). Not a soul has asked about my budgetting methods or wanted to see the meticulous detail. The traditional “due diligence” doesn’t look at enough of the meaningful dynamics (in my opionion).

This is a rough set of on the fly thoughts that I have dwelt on. Forgive and goofs, its 3 am and about the normal time for bed in trying to keep it all afloat during this process. Its nuts to me that back-end value doesn’t matter if things don’t fit into rigid boxes. The myopia I have seen is incredible. From someone who has made a good living from critical thinking, organizational assessment/diagnosis, and probing skills, I have been bafoozled. At the same time, it also gives better understanding to why a 1/3 hit rate is the normative experience.

Before anyone gets too offended, I believe that I can very objectively defend the normative basis of this. Without being seen as arrogant (perhaps unavoidable by this point), I could break down most industries, organizations, leadership teams, without ever getting into the finances of the company and assuredly enhance the VC/PE hit rate. The result, to get back to the relevance of this, is that there are companies that fail, careers demolished, families greatly inconvenienced, because people are not looking through either the right set of glasses, or enough different facets when the start and fund organizations. Thus, later in their life cycle as well, they run into failure that I would contend is like the Lamda effect and more part of bringing forth a genetic flaw of the organization.

Have you seen any other data, studies, etc, that break down the study of failures beyond the typical top 5 list?

Although I generally like VC people better than most bankers and consultants, I see where you’re coming from. Private Equity is a relatively young business with long time horizons and explosive growth over the last decade or so.

Consequently, very few VC’s have much experience with end results and even fewer have hands on management experience. A 27 year old MBA who joins a VC won’t really be able to get a good sense of how things turn out until his mid to late 30’s. I think it’ll take another decade or two for the overall experience level to catch up with the growth.

In any case, I think the growth of Private Equity is a positive development overall. They are much more start-up friendly than other financing options and, in the end, they have to eat what they kill.

As far as sources, the Collins book I mentioned is great, but there is a relative dearth of other sources. Most business books are about success, not failure.

With that Said, I can recommend, “When Genius Failed,” by Roger Lowenstein and “Who says Elephants Can’t Dance,” by Lou Gerstner. Alternatively, you can do what I did and spend a decade or so in the former Eastern Block. Then you will be bale to get lots of frist hand knowledge:-))

I’m sure others will have ideas about where to find information. Hopefully, some will comment.

Thx. In reference to the other discussion,:Stuart’s company, ZenithOptimedia, publishes a worldwide ad expenditure forecast every quarter. If you can get your hands on one (they’re quite expensive) it’s worth a look.

During “Good” times there is a rush of talent and competencies in the company, and during these times many over-confident companies treat employees as just workers, not as partners in their success. They don’t develop a culture of engagement. (http://en.wikipedia.org/wiki/Employee_engagement)

How many market leading companies are also in the “Best places to work”? Few but not many.

Often times Engagement is also one of the hidden key reason why Big giants fail at some point in time.

Thanks for compiling and sharing the key thoughts on How companies fail.

Best,
Nikhil

Note to Jean-Louis:
It is desirable and recommended to look at the positive side. The things become truly positive once you know the negative side as well. Often times, it is best to learn how not to fail while learning on how to succeed.

Mostly people are too busy on learning only how to succeed, and once they are successful, maybe due to fortunate reasons as Greg mentioned, they become over-confident and write their own script for failure in future.

I believe this is a great article which has generated the high quality responses it deserves. My comments will focus on observations which apply to privately owned businesses and professional practices and causes for their failures.

In many cases there is both a lack of strategic thinking and process improvement. Often this occurs because of the confusion in leadership roles, what has always worked to date (don’t fix it if it isn’t broke)resulting in a sense of being bullet proof, the inability to engage talent at all levels and the lack of leadership and management processes to engage human assets. The feeling of being unappreciated and valued clearly will not yield to innovation and process improvement.

Dependency on one or two clients to provide the majority of the revenue.

Poor and untimely management information to run the business.

Lack of capital and dependable banking relationships.

Boredom and lack of expansion rules or criteria that leads ownership to risk too much to expand their business.

Inappropriate means to solve a problem leading to making the problem worse and resulting in the loss of shared purpose

Inability to reach into the lowest levels where the best ideas and process innovation reside.

Obsession with past successes and excessive pride that does not recognize that being in the right place at the right time had a lot to do with past (unsustainable)success.

This best summarizes some of my observations over the past 35 years and supports your closing statement: “Once management loses the passion for developing superior products, serving their customers and creating a great workplace trouble lies ahead.”

With all this said, I still believe that entrepreneurial businesses properly grown have the best opportunity “to get it right”. Many large organizations have lost focus and forgotten why certain processes were put in place- just go through the motions and do not “walk the talk”. The irony is that all levels of leadership and management in smaller organizations need to be better skilled in maximizing human assets than their counterparts in larger publically traded companies.

I do not agree with the point -“Overvaluing Strategies and Undervaluing Processes”.

The reason of disagreement is you create a process because you have a goal (function). Its not other way around.for e.g A Co who is following lower cost strategy like Mc Donald’s would like to have processes that can deliver few items at the fast speed with least cost.Their processes will differ from a restaurant who is selling to those customers that are looking for great variety and with royal prices.

We can say poor implementation of processes can lead you to fail.But You have to have a strategy or goal in place for your customers,employees, and suppliers.

This was a very potent window into how businesses can sometimes become their own worst enemy. I’ve seen this same mistake made over and over again within both small and large organizations. Current and past success causes a cockiness that almost always endangers the possibility for future success.